Illinois’s Mess II

Dave SchulerJanuary 5, 2011

Much of the discussion of Illinois’s fiscal problems in response to my post yesterday dwelled on increasing Illinois’s personal income tax. Illinois can’t solve its problems by increasing its income tax. It can’t solve its problems by increasing revenues period. The numbers just don’t support it.

Illinois has a total budget of $26 billion and a shortfall of $13 billion. In other words to meets its obligations the state would need to double revenue. Here’s the breakdown of Illinois’s state tax revenue:

Sales tax

38%

Business taxes

18%

Fees

14%

Income tax

10%

Other

20%

Presumably, it’s obvious that you can’t double revenue even by doubling income taxes let alone by increasing them by 25 or 30%. Not mathematically possible. Can we double revenue at all? Very doubtful. Doubling the state’s revenue would mean that Illinois would have the highest ratio of taxes to personal income in the nation. The other states with very high ratios (Alaska and Vermont) are distinct cases with conditions that Illinois just doesn’t enjoy. If Illinois doubles its tax rates it won’t realize twice as much money—anybody who can will either leave the state or manage their income in such a way as to avoid the tax.

There’s a desperate problem on the expense side, too. Half of Illinois’s budget is devoted to healthcare and pensions. Not only are these two items the largest budget items, they’re also growing the fastest, expected to increase by 10% year-over-year for the foreseeable future. It can’t constitutionally reduce pensions. Suggesting that Illinois amend its constitution to allow it to cut pensions is dreaming: both houses of the Illinois legislature are dominated by Democrats and public employees are among their core constituencies.

If you need a reason for my continual harping on cutting healthcare costs, that’s a sufficient one.

I don’t think there’s any doubt about it. It’s what the bond guys have been saying for some time.

IMO the whole debacle illustrates the problems of partisan politics at its very worst. Democrats control both houses of the legislature but Democrats can’t benefit by doing what needs to be done to bring Illinois’s fiscal house in order: increase taxes, change to a defined contribution plan for public pensions, hold public payrolls in line, reduce healthcare spending.

Additionally, Illinois has the problems that an inordinate number of safe seats (Democratic and Republican) bring. Nearly all of its federal representative are regular partisans and, consequently, Illinois’s problems don’t get a great deal of attention from the federal government.

Since the taxes will primarily be drawn from the bottom quintiles through cigarette, gambling and increases in the flat income tax rate, I’m not sure people or jobs are at serious risk of leaving. I think the bill to force Illinois consumers, primarily businesses, to pay for one or two unneeded coal plant is more hostile, that’s a tax on manufacturing, schools and sanitary districts.

There will be Republican support for an income tax increase, it will just be interesting to see what they get for it.

It’s highly unlikely. Basically, my wife would need to get a job that would offer her the equivalent in pay and job satisfaction to the one she has now. And it would need to be somewhere we’d like to live. Given her pay level and how much she likes her job that’s pretty limiting.

I’ll never get another job. I’m just too old. For me to go out looking for a job would require total economic collapse. My clients are all local now (I used to have clients all over the world) and the ones I couldn’t handle remotely I could just drop without affecting my income or their service much.

It’s amusing to me that a flat rate has been conflated with a flat tax. Even with Illinois’s single rate much of the revenue from the income tax is from the highest earners. The results of an increase in that rate will probably be to increase revenues a bit, cause some high earners to leave or change how they’re reporting their income, and make the income tax even more regressive than it is now.

But note that a 30% increase in the income tax only results in a 3% increase in revenues (or thereabouts). As I noted in the post, we’d need to double tax revenue to fill the gap and doing that would almost certainly have economic consequences.

Cuts to pensions and healthcare have got to be on the table. That’s just the way the numbers work out.

PD does bring up a good point. In every state with casino gambling locals account for a hefty proportion of gambling revenues. I wonder if the powers that be realize how regressive a tax that is.

I have nothing moral against gambling. I just think it’s a losing proposition overall and probably injures the economies of the states that rely on it. I used to have a client that was a major game machine manufacturer. The house always wins.

Dave, I believe Illinois is the only state with a single flat income tax rate (3%), the effect of which is regressive because of the availability of tax credits and deductions to higher income earners. Neighboring states like Iowa have graduated rates, going from 0.36 % to 8.98%. Generally, Illinois’ taxes are regressive, but the poor and middle-class don’t leave, as long as there are jobs, which is why I think the coal plant issue is a big deal. Of course, higher earners have other options, but Illinois taxes are currently relatively benign to them.

If you need a reason for my continual harping on cutting healthcare costs, that’s a sufficient one.

You are totally screwed. If you can’t deal with the pensions, just give up and let things collapse now. If the pension plan is growing at 10%/year it is only a matter of time before that is the entire budget squeezing out everything else…which we know wont happen.

You have two unsustainable growth trends, you cannot solve the problem by making only one sustainable. If one is impossible to fix then there is no solution. Blubbering on about income taxes and sales taxes, etc. is just a distraction.

steve, Illinois did reform it’s pension system this year by creating a second tier for new hires that is much less beneficial than the existing one. The strategy going forward appears to be push early-retirement, try not to replace workers, if replaced consider using independent contractors, otherwise hire workers with lower salaries and benefits under the second tier. Perhaps long-term this will help.

The short-term problem is that by relying on not paying independent contractors, some of them are declining to continue their jobs or are starting to charge a premium for payment time delay.

It’s a little bit hard to back out of that article, PD, but it can be done. The article is talking about taxes as a proportion of income. I’m talking about taxes paid by the highest earners as a proportion of revenue.

By my back-of-the-envelope calculations, Illinois income taxes account for about half of the revenue derived from the income tax and the taxes paid by the top 1% of income earners (those making more than $395,000) for about a third of that. What I’m suggesting that the top 1% are probably the most likely to either a) bail or b) find a way to avoid paying the increase.

jp, I don’t know California well enough to know how that would work. It just appears to be an effort to bypass property tax caps.

For decentralization to work, I think “the people” have to want it to work. Otherwise, somebody unhappy with his city’s decision, will just go up the ladder and reverse it. This leads to attenuated responsibility and unfunded mandates.

Yes, you’re right, jp. It is related. Although the rhetoric employed and the solutions suggested in Illinois might make one believe that Illinois’s problems are cyclic, e.g. borrowing, Illinois’s problems are primarily structural. Somewhere around here I’ve got a post that demonstrates that pretty conclusively using Cook County and its budget as an example. The short version is that if healthcare costs were just growing at the general rate of inflation Cook County wouldn’t have a budget problem and unless healthcare costs are controlled Cook County’s problems can’t be solved by tax increases.

steve, what’s the deal, your link is to a piece dated 2003, but it has comments from 2010. I really want to read about worse states, but Alaska has a cyclical economy and they’ll be fine unless jp gets the government to mandate bicycles and volts.

Sigh, I will always tell me children that 2003 were the salad years . . .

Heard on the radio today: 1) the votes are not there for an income tax increase, 2) given the schedule of payments, (and its borrowing capcity/bond rating) IL could face a cash flow debacle in 3 months.

IIRC Illinois already has the lowest bond rating of any state, lower than California’s.

Democrats have majorities in both houses of the legislature and the governorship. Simple majorities are all that are required. The inability to increase the income tax is not a partisan issue other than that Democrats aren’t willing to take the responsibility (and, possibly, lose their sinecures) for doing it. Like I said, putting the “fun” in dysfunctional.